Ever hear of the Economic Cycle Research Institute (ECRI)? Chances are that you haven’t but top executives at corporations, hedge funds, etc. certainly have. The reason, of course, is because of the institute’s three generation history of making highly accurate predictions of the business cycle.
According to the ECRI website, “in mid-September 2000, for the first time in nearly a decade, ECRI warned publicly of a coming recession. Then, in early February 2002, it made its economic recovery call. Six years later, in March 2008, ECRI announced that the economy was in recession – a call that remained in force until April 2009, when it predicted a recovery this summer.”
Lakshman Achuthan, managing director at ECRI, says growth in this recovery will be faster than in either of the last two expansions. And although he doesn’t mention a specific number, growth rates in U.S. gross domestic product could surpass an annualized 7% in 2010.
Achuthan says this will be a classic V-shaped recovery. The V-shape refers to the way the growth looks when plotted against time on a chart.
One of the major criticisms aimed at such bullish measures is that they merely reflect the massive monetary stimulus provided by the Federal Reserve and therefore are too narrow. But Anirvan Banerji, director of research at ECRI, does say: “All the key drivers of the business cycle have improved,” and that “goes beyond monetary measures.”
Even such battered sectors as retail could do better than expected.“The consumer cannot be counted out” says Banerji.
Aside from the ECRI, there’s another indicator showing strength; the risk spreads on industrial corporate bonds. Based on an analysis going back 60 years, David Ranson, head of research at HC Wainwright Economics, writes in a recent research paper: “A forecast of 7% growth rates should be conservative.”
In particular, he focused on the percentage difference between the yields for the highest-quality bonds (those rated-Aaa) and lower-quality ones (those rated Baa, the lowest rank within the investment-grade category.)
Spreads indicate investor appetite for risky assets, explains Ranson. Higher spreads indicate lower appetite for risk, and vice versa. He observes that when those spreads narrow more than 0.4 percentage point, economic growth rates one and two quarters later exceed 7%.
But, and here’s the kicker, “the magnitude of recent events is beyond the range of variation in the past sixty years,” he writes.
In other words, we’ve had such a dramatic drop in yield spreads recently that the jump in GDP growth should be truly massive, so don’t rule out double-digit gains this quarter and next.
Now, with all this data pointing to a stronger than expected recovery, what can we expect to see in stocks and currencies? Well, we’ve already seen over 64% of improvement in the S&P 500 so far. My call is to see the index reach the pre-Lehman levels in the first quarter of 2010. As for the dollar, with the Fed (post last Friday’s NFP) still saying that “rates will stay extraordinarily low for an extended period,” expect to see the market come to the realization that the ECB will be talking about raising rates before the Fed. That of course will drive up the common currency vs. the greenback (among others) and it will also help push stocks, gold and commodities higher.
The euro made its dramatic gains against the dollar in 2008 as the Fed reduced borrowing costs while the ECB stood pat. Now, the same thing could happen again as the ECB moves to tighten while the Fed remains stuck between 0.00% and 0.25%.
Of course, the aussie and kiwi dollars look to be big gainers as well. The RBA has already embarked on a tightening cycle and the RBNZ looks set to do so in mid 2010 (giving investors plenty of time to “price in” the move). The pound is likely to be taken along for the ride even as the BoE figures to be the last out. Moves (in pips) could actually be the biggest here since sterling generally trades over a wider range.